During the lessons we have mentioned several times the ZuluTrade drawdown and its maximum value, and we have always said that the way this company shows it is different from what you might think.
In this lesson we will see in the first place what Classic Drawdown means, and we will explore also the version proposed by ZuluTrade, concluding with the consequences and the risks you might run not knowing the difference.
Why Drawdown is so important
However, before you begin, you must have very clear why the Maximum Drawdown of a ZuluTrade Signal Provider is a matter so important to your business as a follower investor. The reason is always linked to the fundamental risk management.
Considered on a trader with a sufficient period of time (minimum one year), the Max Drawdown is the worst moment of the Signal Provider’s history, the period in which the strategy has suffered the most, before recovering. To translate, it’s the worst period you would have suffered if you had followed the signals of that traders, therefore it’s a good starting point to begin with to think about what are the risks associated with that Signal Provider and his strategy.
It should be clarified, however, that past performances are never a guarantee of future performances. This means that if a trader had a Max Drawdown of 1000 pips for many years, it doesn’t mean that in the future he cannot worsen it.
Anyway, since you have the chance to reason only on certain data, and not on assumptions, the Max Drawdown value is definitely the cornerstone for planning risk management in your portfolio.
This is why it’s essential to be clear about what Drawdown means, and be aware if is meant something different, because on this detail you will build the calculation of your risk, which is the most important thing for the success of your investment.
Understanding drawdown is crucial for mastering ZuluTrade, but with many brokers now offering Zulutrade on demo you can still get the chance to ‘test the waters’ of specific signal providers before trading off their signals for real.
The Classic Drawdown
Let’s start from image 1.
This is an example of a traditional drawdown. The chart shown is a Pip Equity Line, and it could very well be that of a ZuluTrade Signal Provider.
Point A is the starting point, that is the first day on which the ZuluTrade Signal Provider has not earned anything yet. The trader starts to work and within a month he realize some profits, let’s say 1000 pips.
Point B is the new amount of the ZuluTrade Signal Provider’s account, after the month since that first day 1. Let’s suppose then that the Signal Provider continued to operate, but this time with less success. After another month of ZuluTrade this trader makes a loss, let’s say of 400 pips.
Point C represents the new balance of 600 pips, after the account on ZuluTrade has grossed the losses. The operations continue, and in the month to come the Signal Provider works well, and his profit are such that he both recovered all the losses of the previous month, and he generated new revenues, such that the account, passed another month, is positive for 1600 pips.
As before, the point D represents the new balance generated by the ZuluTrade Signal Provider, after the last month.
From the current situation, you can make your considerations. The point E is the point at which the account, on ZuluTrade, has returned to the maximum level, which is the point B, and also passed it.
Now the new maximum, the new highest point among all the previous in the ZuluTrade account balance is the point D.
Here is a prerequisite for there to be an analyzable Drawdown. The classic Drawdown is the measure of the balance losses before it has reached a new maximum.
In our example, the drawdown is the measurement between point B and point C, which is the number of pips lost from B to C, before arriving at the point E. We can say that in our case, the ZuluTrade Signal Provider’s account experienced a drawdown of 400 pips.
Of that Drawdown we can also say it had a duration of about one month, ie it took a month before the account came back to create a new profit high.
A very useful way to express it is as percentage. We can furthermore calculate it using two different references:
- Using the amount of pips before the drawdown began. In this case we would have:
400 / 1000 = 0.40
0,40 x 100 = 40 %
This view is very good to understand what happened when the Signal Provider encountered that Drawdown. In this case we can say that on that particular occasion, the trader has lost 40% of the profits accumulated up to that point. It’s a very useful information, but we must contextualize it, especially with the period in which it occurred.
- Using the total amount of pips gained so far from the Signal Provider. In this case instead we would have:
400 / 1600 = 0.25
0.25 x 100 = 25%
This view instead revisits the Drawdown on the total amount of profits, in practice it always assess the extent of the losses, but this time on the earning potential that the strategy has been able to generate. Surely this second way to calculate the DD percentage is the most used, but you must not underestimate the first type, because it can be really useful.
The ZuluTrade Drawdown
The drawdown expressed for a ZuluTrade Signal Provider is the total of the losses caused by the open losing positions only, at a given time.
This is the definition and, to make it more understandable, let’s take a simple example, or rather three.
– If a Signal Provider, at any given time, has 4 open positions, 3 in profit, one in loss of 10 pips, ZuluTrade will tell you that his drawdown is -10 pips at that time.
– If a Signal Provider, at a given time, has 6 open positions, 3 in profit, and 3, respectively, in loss of -10, -15 and -30 pips, ZuluTrade will tell you that his drawdown at that time is -55 pips , given by the sum of the three operations in loss only, at that time (10 + 15 + 30 = 55)
– If a Signal Provider, at a given time, has 4 operations, all 4 winning, ZuluTrade will tell you that, at that time, his Drawdown is 0 (zero) pips.
With these three examples we now have clear what ZuluTrade means for Drawdown and especially how it calculates it. The measurements are made only for the simultaneously open positions in loss, and they are made moment by moment.
Therefore the ZuluTrade MAX Drawdown will simply be the negative amount of pip the instant in which the Signal Provider was losing the greatest number of pips from his open losing operations.
In addition, the ZuluTrade Max Drawdown in percentage is calculated only in the second way that we have seen before, i.e. considering only the total amount of pips accumulated by the Signal Provider.
This interpretation and indication modality, despite ZuluTrade show in its guide how his Drawdown is calculated, have led many novice investors to make errors that in some cases can be very costly.
Rest assured though, because finished this lesson, it won’t be your case. Indeed, not only you will erase the risk that I’m about to show you, but most of all you will start out with a serious competitive advantage when you will select the Signal Providers for your investment. You will understand why ZuluTrade shows this value in its own way, and not rather in a more traditional way.
The difference between the two Drawdown type revealed
Now, I’m about to reveal everything. Let’s take for example a Signal Provider and its data sheet. Here are the stats from the left column.
This is a Signal Provider that doesn’t have an excessive number of Max Open Trades, and he generally cuts his losses and lets his profits run. I have highlighted the Maximum Drawdown value. A 5%, which corresponds numerically to 207 pips. Rather than argue whether or not this is a good value, I would like to show you something else.
Imagine you are an investor who doesn’t know about Investingoal, and by the way that knows very little about Drawdown, and most of all that doesn’t know that the ZuluTrade’s one is expressed in a different way from the usual. A novice investor would be led to believe that this Signal Provider, until now, has lost a maximum of 207 pips before returning to generate a new profit in his equity line.
Let’s see it on the chart. We are in the drawdown tab, the section where we can see where the balance actually went with his losses and winnings. We have selected only the blue drawdown line.
The balance was at 2,198 pips on March 10th, and then it began to suffer a series of losses, not abrupt, but continuous, that within two months have instead led it to 1,358 pips on May 9th.
That’s what we’re talking about: the difference between 2,198 and 1,358 is 840 pips.
840 pips Maximum of real classic drawdown.
840 pips are not 207 pips, not even remotely. In this case the real Drawdown value is four times greater than the ZuluTrade’s one.
Now you understand why I say that if you know certain things, you cannot make certain mistakes, and you can start with great benefit when you will look for your trusted Signal Provider. Indeed, the fact that this Signal Provider has 840 pips of drawdown instead of 207 pips may not be a problem, because everything is relative and proportional.
Knowing that his Maximum Drawdown is 840 pips, you will simply adjust your calculations considering this value to find what assign him, how much leverage and lot size to give him.
The problem is to not base your calculations in the correct manner, as we show you instead.
Why does ZuluTrade shows this type of Drawdown?
For sure, there are two questions you want an answer for.
- Why is there so much difference between the two expressions of the Maximum Drawdown?
- Why did ZuluTrade decide to use this drawdown version?
Finding the Maximum Drawdown as ZuluTrade does doesn’t mean to have identified the moment when the Signal Provider began to recover his losses.
A little while ago I pointed out the main features of that Signal Provider, ie that he doesn’t exaggerate with the number of open trades at the same time for each currency pair, and above all, that he uses stop losses with quite close values. So, he won’t find himself with many positions open at once and in loss, because if they lose too much he closes them, cashing the loss. Therefore the drawdown value reported in the ZuluTrade manner will be low.
But this doesn’t mean that the losses collected on the account by the closed and accounted transactions won’t continue to persist. On one hand this trader doesn’t keep them open, so he doesn’t risk they run too much in loss, but by keeping closing them with small losses, his account will suffer a decline in any case, and this decline will be indeed our classic Drawdown.
So, why ZuluTrade does not show this other value, the classic one?
Let’s answer the second question. ZuluTrade is well aware of the fact that many of the investors who land on its site does not have the right knowledge of the sector. Despite its efforts to explain certain things, it’s often the very people who don’t want to listen. Obviously, this is not your case because you arrived here on Investingoal and you’re interested in this topic.
However, ZuluTrade is well aware that many follower investors, having no experience (and not wanting to make it even) base their decisions on the vision of the Signal Providers’ equity line only, and on the number of pips that they make every day. Many don’t even check at all the risks that these traders take to get those equity and to make pips every day. And ZuluTrade knows that.
As you’ve already seen, the worst systems and strategies are the Martingale, those systems that are developed precisely on a large number of simultaneously open losing trades, those systems which the vast majority of novice investors unfortunately link to. These traders don’t close operations when they start losing, but they rather open others in the same direction to try to recover.
So, if on one hand the account does not suffer closed and accounted losses, on the other the “open” losses, if the market continues in the unfavorable direction, can be enormous.
Here is where ZuluTrade tries to intervene. In fact, with its own drawdown concept, ZuluTrade shows you how much a Signal Provider let his account (then potentially even yours) running in loss, with simultaneously open transactions (up to a maximum of 30), running huge risks, sometimes even burning the account.
In practice, it often tells how much “martingale” that Signal Provider has been.
If you look at the question from this point of view, then this ZuluTrade Drawdown takes on a different light. It’s obvious that they are trying to protect the majority of the new beginner clients, that statistically, as their first Signal Providers, choose those of this type we just seen, because they are more attractive.
On the other hand, inevitably, signal providers like the one of our example are poorly represented, even though they don’t use risky techniques such as the Martingale.
However, this for you is no longer a problem, now you know exactly how to juggle with the Drawdown indications, in all its forms.